Fed is Overloaded With 'Toxic Waste'

The following is part of Pivotal Events that was published
for our subscribers August 23, 2012.

Signs of the Times

"Federal Reserve Chairman Bernanke calls it his 'nightmare scenario'.
Republicans are considering including a plank in their party platform calling
for a full audit of the central bank."

~ Bloomberg, August 8

Why not?

Health agencies have been calling for full clinical testing of "alternative
health remedies" such as homeopathic medicine. The latter could be germane
as it prescribes small amounts of some compounds that are toxic. Now we all
know that large expansions of credit are ultimately toxic. But in the early
days of tax-payer seduction, central bankers touted that they knew just how
much to issue to "manage" the economy. They would never be reckless in providing
stability. Then every country had to have a central bank and a "national economy" resulting
in the longest run of high volatility in history. Sort of a relentlessly forced
instability.

Now the Fed is overloaded with "toxic waste".

Hey, but not to worry! A year after the 2008 Crash, the Financial Stability
Board was formed and based in Basel. It is made up of finance ministers and
central bankers - all specialists in the arts of homeopathic finance.

Somehow this reminds of the BIS. The website of the Bank for International
Settlements states its mission is "to promote international stability".
It was formed in 1930 - a year after the 1929 Crash - and is located in Basel.

"Foreign direct investment in China fell to the lowest level in two
years in July."

~ Bloomberg, August 16

"China Mobile Ltd., the world's biggest phone company by subscribers,
fell the most [-5%] in more than year as profit growth cooled to the slowest
annual pace in 13 years."

~ Bloomberg, August 16

Perspective

Only a few weeks ago, stock market sentiment figures were at very bearish
readings. This was prompted by the prospect of Spain's insolvency, Euroland
splitting up and the worst drought in the US in fifty years.

Not all could be enduring. Crops will soon be harvested and the drought will
no longer be in the headlines. Grains will turn down.

In the meantime, often seasonal optimism could run into early September. Spanish
yields have declined and industrial commodities (base metals and crude) have
rallied as well.

Even most classes of bonds have rallied this week. This could be anticipating
a pause in the stock market advance. Investment-grade corps, treasuries and
emerging market debt are doing well, but the sub-prime seems to be topping
(chart follows).

On money market stuff, the Ted-spread has narrowed significantly since the
concerns of late last year. However, in the past two weeks it has had some
unusual swings. Perhaps some volatility prior to a change.

An overall blessing has been the decline in the gold/silver ratio. From 59.4
in June it has declined to 54.5. Much of this has been accomplished in a rush
since last week. Enough of a rush to drive the daily RSI down to 27. This has
been the RSI level that has ended most of the declines over the past decade.

In looking at the ratio from the other direction, Ross's Silver/Gold Chart
is updated and attached. By this measure, the rally in precious metals is close
to ending.

Usually our Pivots are sent out earlier on each Thursday, but things looked
fascinating yesterday and much of today was spent trading. In order to get
this one out a simpler form is being used.

Also noteworthy is that December corn has completed a "Sequential Sell" pattern
that suggests an important top is at hand. The rollover would likely take down
other hot agricultural commodities (GKX).

Momentum on the GKX reached 82 a couple of weeks ago and that has ended important
rallies over the past decade. One of which was with the cyclical high in 2008.
That high was 513 on the index, the next important high was 570 in March last
year. So far, this year's high was 533 a couple of weeks ago - with the momentum
high. Today's close was 513.

Crude oil has accomplished an outstanding swing from very oversold to rather
overbought. Also yesterday's ChartWorks noted that a "Sequential 9" had been
accomplished. Also the Dollar Index is approaching support at the 81 level.
Last week we noted that the Canadian was approaching resistance at 102 on good
momentum. It reached 101.6 and it has declined to 100.5. Technically, a test
is needed to reverse the trend, but weakness in the fall has been likely.

While we have been hoping the sunshine for orthodox investment would run into
early September, the actual seasonals for the stock market suggest caution.
Over the past thirty years the S&P has set its August high early in the
last week of the month. Remember the rules for after Labor Day - Don't be overweight
equities and don't wear white shoes.

With the initial discovery of financial troubles the flight to the liquidity
of gold could help the price in dollars, but the "flight" could also be to
the unique liquidity of US treasury bills, which would firm up the dollar.

Wrap

The advice through the summer has been to sell into the rallies for most
investment sectors. The hit to US bond markets has been a big heads up and
the rebound could run for a week or so.

It seems that another liquidity problem will not be avoided. The process
of discovery could begin in the next few weeks.

In which case, which sector could provide the "safe haven"?

In the disaster that began in March 2000 banks became the defensive equity
group. The long bond rallied from 91.8 in March 2000 to 110 as the crash
completed in late 2002.

In the 2008 Crash, long bonds also enjoyed the "flight to quality" in a
bull move from 105 in mid-2007 to 143 at the end of 2008. There was no significant
defensive equity sector.

This time around, there may be no large equity sector that could be defensive.
Moreover, the European bond revulsion could worsen and spread to the US bond
markets. In which case, the long bond will not become the focus of the next
flight to quality. A sound understanding of term risk could prevail.

Representative Sub-Prime Mortgage Bond

The RSI of the Silver/Gold ratio suggests that it is time to start scaling
back positions in miners. Optimum gold targets are $1692 & $1720.Larger
Image

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